We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What Is the Connection between Discounted Cash Flow and Net Present Value?

Jim B.
By
Updated: May 17, 2024
Views: 7,474
References
Share

Discounted cash flow and net present value are two concepts that are connected in the world of finance because the discounted cash flow essentially determines the net present value. It does this by taking into account the fact that money loses value over time, meaning that a sum of money in the future will not be worth as much as the same sum of money in the present. By discounting promised future cash flow, the net present value of that amount can be determined. This is a beneficial calculation to make when a financial decision needs to be made about an investment or project that promises to bring in a certain amount of money over time.

Making business decisions can be difficult even when one possible choice is almost certain to bring in a future amount of money. That is because inflation in economies is practically guaranteed over time, meaning that a certain amount of money in one's hand at the present time is more valuable than that same amount in hand years down the road. The time value of money is a crucial concept to understand, and it's at the heart of the relationship between discounted cash flow and net present value.

To understand how discounted cash flow and net present value are connected, it is helpful to think of an investment that promises interest payments. If the investor reinvests the interest, the interest is compounded and adds more to the amount of each payment. An inverse relationship to that takes place concerning some amount of money in the future and its actual worth in the present.

If the future value is known, a discount rate can be used to reduce this amount back down to its present value. This is done in practically the same way as the compounded interest calculation. Just as an investment with compounded interest becomes more valuable the longer it is held, a sum of money becomes less valuable if it is realized many years in the future. The amount left in the present after the discount has occurred is the net present value.

It is important when considering discounted cash flow and net present value that a proper discount rate is chosen. Those making the business or investment decision have to determine this rate based on a number of factors. Chief among them is the amount of risk involved that the investment may not reach the predicted future cash flows. If there is a high risk of this occurring, the discount rate should be proportionately high to account for this.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Link to Sources
Jim B.
By Jim B.
Freelance writer - Jim Beviglia has made a name for himself by writing for national publications and creating his own successful blog. His passion led to a popular book series, which has gained the attention of fans worldwide. With a background in journalism, Beviglia brings his love for storytelling to his writing career where he engages readers with his unique insights.

Editors' Picks

Discussion Comments
Jim B.
Jim B.
Freelance writer - Jim Beviglia has made a name for himself by writing for national publications and creating his own...
Learn more
Share
https://www.wisegeek.net/what-is-the-connection-between-discounted-cash-flow-and-net-present-value.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.